Just share an insight about why a prevalent inflation reasoning logic “more supply money chasing few goods ” is faulty .
Traditional view of inflation in current macroeconomics is based on Milton Friedman’s famous saying that “inflation is always and everywhere a monetary phenomenon” In this view, higher price level P is due to more supply money (M) chasing few goods(Q) in MV = PQ.
Traditional view in fact contradicts the economic accounting view of inflation, which is more productive money producing few goods”. An accounting identity about inflation is:
In chart below,
As you can see, green dash line(inflation) is much more aligned with blue line (more productive money producing few goods) than red line (more supply money chasing few goods)
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I’ve been studying this for days. As you know, I’m a scientist, not an economist.
The main difference between nominal GDP and real GDP values is that real values are adjusted for inflation, while nominal values are not. As a result, nominal GDP will often appear higher than real GDP. In this chart, we have the % CHANGE of GDP compared to the year before. The % CHANGE of GDP (real or inflation-adjusted GDP), are very similar lines. In fact, you can hardly see the Green dashed line under the Blue line since the % CHANGE is of course nearly identical. So, how could “Green dash line = %P = Inflation”. It’s the %Change of inflation compared to the year before.
I actually don’t like looking at %CHANGE year-over-year over time (especially long times), because it grossly exaggerates the facts. In the “olden days” the %CHANGE year-over-year could be HUGE without this being much moolah at all. Whereas today getting a 10% change %CHANGE year-over-year is billion$. I don’t know why this particular FRED graph doesn’t have an indication that this data is a % Change year-over-year, but maybe it’s because I should have known that. At any rate, pliu412 pointed that out.
“Nominal values of GDP (or other income measures) from different time periods can differ due to changes in quantities of goods and services and/or changes in general price levels. As a result, taking price levels (or inflation) into account is necessary when determining if we are really better or worse off when making comparisons between different time periods. Values for real GDP are adjusted for differences in prices levels, while figures for nominal GDP are not.
“The GDP Deflator
If we wish to analyze the impact of price changes throughout an economy, then the “GDP deflator” is the preferred price index. This is because it does not focus on a fixed basket of goods and services and automatically reflects changes in consumption patterns and/or the introduction of new goods and services.” Investopedia
Below is the “GDP deflator”, e.g. the correction due to inflation of the nominal GDP that gives us the real GDP. When one studies this year-over-year change, it doesn’t look that dramatic.
On the other hand, the “money supply” indicated by the Red line, are the funds in the banking system, in what Cullen calls “outside” money held by the banks together with the Central banks, that is not actually “IN” the economy. It’s available for lending, but what does that do for the economy (nominal or real GDP)? Nothing unless folks actually borrow it?
What that did, at the time, was to keep our banks and those of the world from going under, and that’s all. Although most all the banks were technically insolvent, they were allowed to make loans and stay in buisness. Thank goodness for that RED LINE.
Pliu412 relevation is what it is. Friedman was in a different time zone. “Milton Friedman’s famous saying that “inflation is always and everywhere a monetary phenomenon” In this view, higher price level P is due to more supply money (M) chasing few goods(Q) in MV = PQ.
Pliu412: ” “more supply money chasing few goods ” is faulty .” More money actually IN THE ECONOMY “productive money”, chasing over priced assets is the cause of inflation. Today that is exactly what we have.
??? Why no inflation ??? Well we have inflation of assets and property, but not goods and services.
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Hi Biologist(?) Dennis,
As a retired data scientist, I can chart time-series data to clarify used economic variables related to inflation rates/price levels, meaning of RGDP/NGDP/Q, and inside/outside/productive money from accounting perspectives. Then I would like to describe an economic methodology I practice to reason about economic issues. Unfortunately, this sound methodology, for some reasons, never be taught in current macroeconomics. Maybe this is where you got confused about what I am doing. We have many schools of economic thought or ideology to reason about economic issues in different ad-hoc ways.
(A) Inflation Rates/Price Levels(CPI, PCE, P, PPI)
One of your charts shows 4 inflation rates and another chart shows P(GDP Implicit Price Deflector) price level. My chart below shows 4 inflation rates on left hand axis same as one of yours and 4 price levels on right hand axis. In Fed chart tool, you can easily change time-series units and algebraic formula of used terms shown in chart title by clicking menu “Edit Graph” and then submenu “Edit Lines”. Fed database may already have both rates and price levels time-series data. But we can pick up price level time-series data and change the unit to (YoY % change) in chart tool.
In writing, I use CPI, PCE, P and PPI for price levels and notations %CPI, %PCE, %P and %PPI for inflation rates.
%CPI, %PCE, %P and %PPI just have different scopes of produced goods/services in inflation measurement.
(B) P*Q = GDP and meaning of Real GDP and Q
In chart below, I show price levels of RGDP, GDP and P*RGDP and growth rates %P, %RGDP and %GDP.
Once knowing the base accounting identity P*Q = GDP, then we can derive other related accounting identities by using time-series algebra such as
P = GDP/Q,
In previous chart, green dash line = %P = Inflation rate = %NGDP – %Q – (%NGDP – %Q)*%Q/(1+%Q) . Green dash line is almost overlapped with blue line, which is %NGDP – %Q since (%NGDP – %Q)*%Q/(1+%Q) is close to 0.
In time-series formula, blue line (%NGDP – %Q) should be read as “more productive money (%NGDP) producing few goods(%Q)”, which is close to inflation rate(%P) since (%NGDP – %Q)*%Q/(1+%Q) is close to 0.
No matter it is outside or inside supply money, the thinking of “the more supply money ($M) chasing few goods (%Q) for causing inflation” is not consistent with accounting data. Cullen often uses operational realities to invalid the economic concepts. We can also invalid the concepts from accounting data realities without using operational realities. As you can see the chart below, both outside supply money %MB-%Q (red line) and inside supply money % domestic non-financial sectors credit market Instruments: liabilities – %Q (yellow line) are inconsistent to inflation rate %P (green dash line). Only blue line is consistent with %P. It is not NO inflation. You have to read blue line as “more productive money(%NGDP) produced few goods(%Q)” for causing inflation(%P). Only partial supply money is going to productive money counted as GDP(= I+C+G+X-M spending).
(C) Correct economic methodology is sensor-based diagnostic reasoning logic
Economic accounting data are measurements of real economy and time-series accounting data should be viewed as “sensor data” to our economic machine. We measure both pre-production investment spending for acquired equipment, IP, etc, wages for used labors and post-production consumption, imports and exports of produced goods/services. We measure price levels, then we estimate the total quantity of produced goods/services inside this economic machine. We can know the performances and problems of this economic machine only by using sensor data and their relationships
Relationships of time-series sensor data can be correctly derived by using top-down decomposition approach. Bottom-up composition approach such as regression, parameter system identification, etc. is pone to the fallacies of composition and contradicting to sensor data in accounting, the ground truth of economic data.
Relationships of time-series accounting data may not be unique. For example, inflation rate can be calculated by either %P = %NGDP – %Q(more productive money producing few goods) or %P = %ULC(Unit Labor Cost)+%ULP(Unit Labor Production), shown here https://www.pragcap.com/ama/cpi-targeting/#answer-7534
IMO, the art of this economic machine diagnosis is to find out useful perspectives of this economic machine by sensor data relationships and to reason about this machine status by the meanings and operational realities behind time-series numbers.
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Pliu412, Yes I’m in a totally different area of research (Organic Chem, Molecular Biology, Patent Agent), than you. Often my response questions seem like challenges, but that was not my point at all. I was just trying to noodle your post with my weak understanding. Thank you so much for spending so much time and effort on this. I think what you are expressing is very important, and I want to “get it”. I’m going to study your post for awhile. Thank you again for helping me, and maybe others.
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I like to hear any of your technical comments and challenges. Shaky foundation of macroeconomics was built upon 4 broken economic “laws” (law of demand, law of supply, Say’s law and Keynes’ law) and has never been seriously challenged. Our economic accounting data is based on “income=spend” and “assets = liabilities”. Unbelievably diverge!!
I add a PCE version chart for your reference.
TS algebra is something like this.
%PCE = %NGDP – %(Q*P/PCE) – (%NGDP – %(Q*P/PCE))*%(Q*P/PCE)/(1+%(Q*P/PCE))
Green line = Inflation(%PCE)
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